china’s consumer market: what next? - · pdf filethe report offers predictions about the...

A Deloitte Research Study

China’s consumer market: What next?

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Table of contents

1 Introduction 2 Selling consumer products in China 4 Changing landscape for distribution 7 China’s retailing industry 9 The consumer economy in China 21 China and the internet 22 Short term economic outlook 23 Strategic requirements for success 24 Concluding thoughts

About Deloitte ResearchDeloitte Research, a part of Deloitte Services LP, identifies, analyzes, and explains the major issues driving today’s business dynamics and shaping tomorrow’s global marketplace. From provocative points of view about strategy and organizational change to straight talk about economics, regulation and technology, Deloitte Research delivers innovative, practical insights companies can use to improve their bottom-line performance. Operating through a network of dedicated research professionals, senior consulting practi-tioners of the various member firms of Deloitte Touche Tohmatsu, academics and technology specialists, Deloitte Research exhibits deep industry knowledge, functional understanding, and commitment to thought leadership. In boardrooms and business journals, Deloitte Research is known for bringing new perspective to real-world concerns.

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Deloitte Research China’s consumer market: What next? 1

Introduction

In the midst of a serious global economic crisis, in which China’s economy has markedly slowed, it may seem an odd time to offer an optimistic prediction. Yet all signs point to a consumer spending boom in China over the next several years. The global economy has reached an inflection point, in which the structure that existed over the past decade shifts dramatically. During the past decade, the engine of global economic growth was the US consumer. China grew largely by supplying exports to the US consumer market. Going forward, US consumer spending will grow more slowly as the vast imbalance in the US economy is corrected. Likewise, China’s export growth will lessen and the Chinese economy will experience growth based largely on domestic demand, especially the consumer. This will likely be brought about by a confluence of factors including a rising value of the Chinese currency. This very likely will reduce import prices and raise the purchasing power of Chinese consumers. In addition, China’s policymakers will probably stimulate consumer demand, discourage saving, and encourage industries that focus on the needs of Chinese consumers.

For the world’s leading retailers and consumer product companies, most of which are based in North America or Western Europe, the rise of the Chinese consumer will have vast implications. The home markets of these companies are no longer sufficient to drive the growth shareholders seek. Not only are these markets saturated and increasingly fragmented, they are not likely to grow at sufficient speed in the years ahead. In the US, a decade of excessive consumer borrowing augurs a period of retrenchment and greater consumer frugality. In Europe slow population growth, combined with an aging popula-tion, imply stagnant growth and a shift in consumer spending away from goods and toward services. The same can be said for Japan as well.

Instead, emerging markets are likely provide consumer oriented companies with an increasing share of sales and a disproportionate share of growth. The most notable such emerging market, of course, is China. With the world’s largest population, the fastest growing major economy during the past decade, the second largest economy in the world (when measured according to true purchasing power), and an increasingly sophisticated middle class, China will be indispensable.

In this report, Deloitte Research considers the changing consumer business environment in China. The report offers predictions about the evolution of the Chinese consumer market as well as the likely strategic implications for global consumer oriented companies.

The report is organized as follows: First, the requirements of selling consumer products in China are discussed. The changing distribution landscape and the evolution of the retail marketplace are also examined. Then, the report delves into the nature of the market, including living standards, spending behavior, consumer attitudes, consumer finance, demographics, and the increasing role of the internet. The report also looks at the current and near term economic environment facing consumers. The report concludes with a discussion of the strategic requirements for success in the Chinese consumer market.

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Selling consumer products in China

What does it take to succeed in the Chinese market for consumer products? Most of the factors for success are the same as they would be anywhere else, yet some are unique to China. Globally, consumer product companies face several challenges. These include an increasingly value-oriented consumer who is driven by price considerations. As such, they are attracted to private labels and discount retailers. In addition, the consumer market is increasingly fragmented, driven by an equally fragmented marketing experience. Also, power in the supply chain has shifted decidedly in favor of retailers as opposed to their suppliers. As such, consumer product companies are struggling to enhance their relationships with key retail accounts.

In response to this business environment, success for consumer product companies will come from product innovation aimed at avoiding commoditization and retaining pricing power. In addition, these companies will shift incrementally away from mass marketing and toward networked interaction with consumers, the goal being to enhance brand equity and empower consumers in the process of product development. Finally, these companies will seek greener pastures in the form of emerging markets for future growth. That is where China comes in.

In China, where most of the world’s leading consumer product companies already operate, success requires many of the same ingredients as in home markets. However, there are differences. First, as discussed later in this report, China lacks a national market — at least for now. Consumer product companies need to be organized around regions. They must develop distribution and focus their marketing messages according to the needs of local markets. These markets can vary considerably according to language/dialect, spending power, tastes, and consumer culture.

Second, although China is becoming more affluent, it remains a relatively poor country. Consumer products must be affordable. This requires a particular focus on cost of production, especially the cost of packaging. Most Chinese do not yet own automobiles and many travel to stores on foot or by bicycle. Thus, most transactions at hypermarkets and supermarkets are small not only in price, but in size. Thus, it makes sense to produce SKUs that are likewise small in size and price.

Third, product innovation and enhancement must be geared toward the needs of local consumers. It would not be sufficient to simply replicate products that are sold in affluent markets. Appropriate product innovation naturally requires a strong understanding of consumer behavior. Traditional market research techniques are not sufficient in China as they tend not to render very useful insights. That is due to the tendency of Chinese consumers, when surveyed, to tell questioners what they want to hear. Instead, close observation is required. In addition, the Internet can be a useful tool for interacting with consumers and bringing them into the process of innovation. The great and growing enthusiasm on the part of young consumers for the Internet can be exploited to the benefit of consumer product companies.


Fourth, as millions of China’s consumers experience increased incomes, their incremental spending is not necessarily geared toward fast moving consumer goods. If a consumer becomes more affluent, they won’t neces-sarily purchase more paper towels, soaps, and detergents. Instead, they are likely to seek larger homes, electronic gadgets, and purchase services such as restaurant meals or holidays. Thus, the challenge for consumer product producers is to attract greater discretionary funds from such consumers. This can entail market segmentation in which consumers are encouraged to switch to a more premium brand. Such a sub-brand would have to possess features that appeal to a more affluent consumers and would have to be marketed as such.

Finally, there is the issue of distribution. China’s retail market has become more sophisticated and consolidated than in the past. Yet it remains relatively fragmented compared to more affluent markets. There are countless small independent stores, street markets, and inefficient state-run retailers. Navigating this landscape can be costly. For global companies, focusing more resources on the modern retail sector is sensible in that it is more efficient, cost-effective, and will grow more rapidly in the future.

In the near term future, global consumer products companies will continue to expand in the Chinese market. In some instances, this will be undertaken through acquisi-tion of local brands. The expectation will be that global companies can provide these brands with expertise in distribution, marketing, as well as deep pockets. The local companies will be expected to have a good understanding of local consumers as well as strength in low cost manu-facturing. The trick will be to combine the competencies of both organizations to make the whole greater than the sum of the parts.

The challenge, however, will be to carefully perform due diligence when considering acquisitions. There is a long history of surprises that Western companies have encountered when gaining control of Chinese companies, especially when the companies in question were state-owned. Often the problem is that financial records are not sufficiently transparent. Another problem, mainly with state-owned enterprises, is that existing management is often chosen for and motivated by political considerations. Yet many acquisitions have involved obligations to retain management. Such arrangements can cause the benefits of an acquisition to unravel.

There is a long history of surprises that Western companies have encountered when gaining control of Chinese companies, especially when the companies in question were state-owned.

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Changing landscapefor distribution

The rise of modern retailing Modern big box retailers usually offer no price advantage over traditional wet markets and street vendors. Indeed the prices charged in the informal sector are often lower than those at modern retailers. Yet the moderns continue to gain market share — although that gain is mainly at the expense of state-owned department stores rather than the informal sector.

Why are consumers attracted to modern retailers? The answer is that modern retailers have several advantages. When it comes to food, they offer reliable hygiene, air-conditioning, and the convenience of one-stop shopping. In addition, modern stores stay open longer than tradi-tional markets and thus attract shoppers returning home from work late in the day. Also, consumers are generally confident that major fashion and home fashion brands sold at modern stores are not fakes, unlike those sold through informal channels.

Still, when asked about their primary competitors, leaders of modern retailers in China are apt to list street markets and street vendors rather than other big box operators. They complain that street merchants pay no taxes and needn’t pay rent. The result is low prices and a certain kind of convenience. The challenge for big box retailers is to retain the ambience of wet markets while offering the advantages of modern retailing. In the case of Walmart, managers at each store visit nearby wet markets and inde-pendent stores as often as three times each day. The goal is to see what items are selling well and at what prices. This enables Walmart to quickly respond to changing demand patterns.

When asked about their primary competitors, leaders of modern retailers in China are apt to list street markets and street vendors rather than other big box operators. They complain that street merchants pay no taxes and needn’t pay rent.


Shopping centers Many large shopping malls have been developed in and around major cities in recent years. Most mega malls in China house food courts, restaurants, cinema halls, leisure centers, specialty stores and department stores. The malls offer a new type of shopping experience for consumers in major urban centers. In Shanghai’s shopping centers, sales growth was 14 per cent higher than the city’s overall retail sales growth in 2006. Luxury retailers have been willing to pay high rents in malls that have good locations.

However, many of the recently completed mega malls, such as the South China Mall in Guangdong Province, are located in suburban areas which are not easily accessible to the average Chinese consumer. Car ownership in urban China is still very low. Consequently, a mall located far away from the city center fails to attract crowds.

Many malls are too large to attract a sufficient number of retail tenants. The South China Mall is a case in point. Moreover, there are very few Chinese retail chains that are capable of becoming anchor stores of these malls. Had these malls been developed in consortium with prominent retailers or department stores, the planning, layout and utilization of these malls might have been more effective.

Food and store safety In a country that has seen several scares involving disease-ridden food, the issue of food safety is critical for food retailers and suppliers. Although the government has strict rules regarding management of the food supply chain, modern retailers have invested heavily in quality control in order to avoid crises. The ability of food retailers and suppliers to maintain a reputation for food safety and quality is critical to their success. For the large hypermarket chains, food drives the traffic that enables the stores to sell non-food merchandise as well.

The Chinese government has recently approved a food safety law to regulate food standards. The law mandates release of information about food safety and has provi-sions for imposing high fines on non-compliant companies. The law, which went into effect on June 1st, 2009, also

contains provisions for inspection of food exports and imports. Signaling its intent, the Chinese government launched a food safety campaign in 2007 and came down heavily on unlicensed food suppliers and restaurants. Going forward, food companies will have to be more vigilant with regard to procurement and retailers will need to obtain substantial information from suppliers before putting items on shelves.

In the cases of both food and store safety the danger is that, if something bad happens, the local press will become aggressive in reporting the problem and potentially destroy the reputation of a retailer or supplier. In China, the press has been privatized and, in order to drive circulation, is aggressive in going after private enterprises (especially as they cannot go after the government with impunity).

Foreign food retailers and suppliers have the advantage of being known for their safety and hygiene. Global brands can, to a certain extent and in a subtle manner, exploit this advantage in their marketing campaigns. Also, consumers in China are reputed to have a greater regard for the safety of fresh as opposed to packaged foods.


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Market research One of the great challenges of operating in the Chinese consumer market lies in understanding the consumer. Traditional research techniques can yield inaccurate results. That is because consumers are often apt to provide researchers with misleading information. There is a cultural aversion to telling people things that might be offensive or embarrassing. For example, Chinese consumers might not want to offend a company by saying that they dislike their products. They might not want to admit that they cannot afford to purchase something. Such aversions will lead to inaccurate research results. Therefore, research must be conducted in less transparent ways. That is, consumers must be observed at close range. Experiments must be conducted in order to determine what works and what does not. Clearly, this kind of research is more expensive and time consuming than traditional modes. Yet it is more likely to yield robust information.

Distribution Distribution in China is getting better. Anyone who has talked to business executives operating in China has probably heard a few horror stories concerning the movement of goods. Those horror stories still take place, but fewer and far between. The reason for the improve-ment is the massive investment in transportation infrastruc-ture made by the government. The result is much lower lead times.

On the other hand, there remain serious problems. For example, the movement of perishable goods can be chal-lenging owing to the paucity of refrigerated trucks and distribution facilities. Thus most retailers operate localized distribution of perishables while they are starting to engage in national distribution of non-perishable goods. Carrefour, for instance, operates most of its stores as self-contained units that are responsible for their own purchases, and thus requires them to develop good relationships with local distributors. In so doing, Carrefour stores are able to customize their merchandise according to the tastes of consumers residing in each location.

Human resources In discussions that Deloitte Research conducted with global consumer companies operating in China, the issue that kept coming up repeatedly was human capital. The ability to execute a strategy is entirely dependent on the ability to find and retain good quality managers — an increasingly challenging endeavor. Companies often begin their journey in China with a large number of expatriates. Yet this is not sustainable as expats are costly and usually are eager to return home after a few years. Optimally, a foreign company in China should rely on a small number of expats and a large and growing number of local managers.

Yet retaining local managers is problematic. Due to the enormous economic growth, and especially vast foreign investment, the demand for skilled managers is growing faster than the local supply. Hence, labor costs for managers have risen rapidly. Moreover, managers find that there are often new opportunities at local companies, especially after they have received valuable training from global organizations. Instilling a sense of loyalty to the company and a sense of long-term opportunity has been especially difficult for global companies operating in China. Short term financial opportunities with Chinese companies are often highly tempting.

Another human resource issue is the problem of inte-grating people into what is essentially an alien culture. Foreign companies investing in China must adjust their corporate cultures to the local environment. The primary issue is one of finding the right balance between the core strengths and strategy of the company and adjusting to the needs of the local market. This is as true of human resource management as it is of merchandising.


China’s retailing industry

China’s retailing industry has been going through a rapid change. Until the mid-1990s, the industry mostly consisted of state-run department stores, small independent shops, and many street markets. These all continue to exist. Yet in recent years there has been a proliferation of hyper-markets, supermarkets, and convenience stores in the big coastal cities. Lately there has also been a rapid increase in the number of non-food specialty stores — both small stores that sell apparel as well as large stores selling elec-tronics, furniture, and other home related goods.

Many of the modern retail stores that have been developed in recent years are foreign invested. Such leading retailers as Carrefour, Metro, Walmart, Auchan, Ikea, and B&Q to name a few have been at the forefront of retail investment in China. While the global economic crisis has dampened short term investment plans, most foreign retailers are planning to rapidly expand in China in the next few years. It is very likely that such expansion will take place through acquisition of domestic retailers. Best Buy and Walmart have recently acquired Chinese retailers to expand their presence. Best Buy got immediate access to 136 stores across China after its purchase of a majority stake in Jiangsu Five Star Appliance. Similarly, Walmart took 101 Trust-mart hypermarkets under its wing in 2007 after it purchased a 35% stake in Bounteous Co., the parent company of Trust-mart. By 2010, Walmart plans to take complete ownership of Trust-mart.

While the global economic crisis has dampened short term investment plans, most foreign retailers are planning to rapidly expand in China in the next few years.

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In addition, there are now several leading local retailers in China that operate modern formats with great success. These include Lianhua, Hualian, and Wumart, each of which operates hypermarkets and supermarkets. In addition, there are some leading local specialty chains such as Gome, a large chain that sells electronics. Still, the top 100 retailers in China account for just 11.2% of total sales of consumer goods.

The largest domestic retail chain in China is Lianhua. It operates close to 4,000 stores all across China. Moreover, Lianhua is now part of a larger retail conglomerate that was created through a government sponsored merger of several Chinese chains. Known as Bailian, this conglom-erate was created by the merger of Shanghai Number One Department Store, Shanghai Hualian, Shanghai Friendship, Shanghai Material Trading Centre, and Hualian Supermarket. Shanghai Friendship is the parent of Lianhua, China’s largest supermarket chain. Although this and other mergers are intended to create organizations with the large-scale efficiency to compete with global giants, there have been problems in integrating different organizations. Indeed these new giants are, to date, principally holding companies rather than large-scale retail organizations. Whether integration and centralization of processes will proceed smoothly in the future is not clear. Still, more such mergers are likely as the government would like to create organizations that have the potential to compete with global giants.

The most important modern format continues to be the hypermarket. These large stores offer food and general merchandise in an environment characterized by self service, centralized checkout, and relatively low prices. In Shanghai, hypermarkets account for more than 45% of the value of sales in the grocery sector. It could be argued that this represents over-saturation considering the current size of the market. Yet if growth continues at a strong pace the demand for such stores will grow as well. Moreover, they will continue to take market share from department stores and street merchants. Still, the lion’s share of hypermarket growth in coming years will come from development of stores in second-tier cities. Each of the major foreign players is now aggressively investing in such locations all over China. The loosening of regulatory restrictions as well as the vast improvement in transportation infrastructure made this feasible.

As for the ubiquitous state-owned department stores, which continue to play a leading role in the retail indus-tries of many of China’s second tier cities, they are good candidates for future privatization. These stores are usually owned by local governments. They tend to be poor merchants, highly inefficient both in terms of supply chain management as well as customer service, and often lose money. Some have been partially privatized. In such cases, these companies have developed a variety of strategies for improvement. Some have invested in alternative formats (supermarkets, specialty stores, hypermarkets), while some have sought to become better merchants.

Consider again Parkson, the Malaysia-based department store division of the Lion Group. It has sold management contracts to Chinese department stores. In these cases, the stores are re-branded with the Parkson name and offer modern merchandising with an attractive assortment of major local and global brands.


In the past decade, the Chinese economy grew at an extremely rapid pace resulting in a huge increase in the number of middle class consumers. Hence the current interest in China’s burgeoning consumer market. Going forward, the long-term economic future for China appears bright. There are good reasons to believe that China’s rapid growth can be sustained for several decades. The result could be a country with a large number of affluent and middle income consumers.

Why is the outlook positive? The answer is that China is in a position similar to that of Japan and Korea in past decades. That is, China is catching up to the world’s rich countries by investing in new capacity, adopting modern technologies, and consequently rapidly increasing the productivity of its workers. Maintaining the rapid growth of recent years will require several factors. These include continued investment in infrastructure, education, and public health — investments that are today at the heart of the government’s economic stimulus program. In addition, rapid growth will require China’s government to accelerate the process of privatizing state-owned companies as well as allowing greater foreign involvement in China’s domestic sector. Notably, the government is now keen to shift the focus of Chinese business away from low-end export oriented production and toward higher value-added manu-facturing as well as services. In so doing, it will accelerate the shift toward a more balanced and efficient economy.

On the other hand, there are two important risks associ-ated with China’s long-term growth. First, in order to sustain rapid growth, China must make a further transi-tion to a more market oriented economy. That transition is laden with risks. These include managing the necessary transition away from export oriented growth, difficul-ties associated with reforming the financial sector, social dislocation from privatization of state-owned enterprises, managing the vast migration of people from rural to urban locations, and avoiding asset price bubbles along the way. Indeed as mentioned earlier, China’s economic slowdown in 2009 is not only due to the global crisis but is also the result of the government effort in 2008 to pop the property price bubble.

The consumer economy of China

China’s consumer market Focus area of publication 9

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Second, long-term growth will necessarily entail China consuming a much larger share of the world’s natural resources. Already this process has had a profound impact on global commodity prices as well as a severely negative impact on China’s environmental quality. Although long-term growth will require more efficient usage of resources, it will probably have a permanent effect on global commodity markets. This, in turn, will have geopo-litical ramifications. The manner in which China and the rest of the world manage this process will affect growth and stability. Indeed China has already begun to scout the world in search of secure sources of oil and other commodities. In addition, China has started down the path of reducing energy subsidies that tend to discourage more efficient use of resources.

Consumer spending In recent years, consumer spending in China rose rapidly. Yet it did not rise as rapidly as the overall economy and not as rapidly as consumer income. For example, from 2000 to 2006, per capita disposable income of urban Chinese increased 87.2% while per capita spending of urban residents rose 74%. During that same period, total consumer spending in China rose 74.2%. As such, consumer spending dropped to an unusually low 36% of GDP (compared to over 70% of GDP in the US). In the years ahead, consumer spending is likely to rise signifi-cantly as a share of GDP as the economy restructures away from export dependency. Thus, overall growth of consumer spending is likely to be quite rapid.

As overall spending rose in the past decade, spending on food fell to 35% of total spending in 2006. This was down from 48% in 1997. Such a decline is to be expected when an emerging country economy grows thereby leading to greater discretionary spending power. Share of consumer spending going to transportation, telecoms, education, housing, entertainment, and medicine and healthcare have increased significantly in the last few years and will continue to do so.

Living conditionsThe shift in spending toward discretionary items and services was related to a shift in living conditions that resulted from a bigger economy. For example, during the period 2000 to 2005 per capita urban building space rose 28.5% from 20.3 square meters to 26.1 square meters. This was due to a vast increase in the housing stock, with newer homes tending to be larger than in the past. It also was due to a reduction in the number of people per household. As homes got larger and incomes rose, people could afford to purchase more durable products and had more space in which to store them.

Interestingly, even relatively poor households enjoyed the fruits of economic growth. For example, the share of urban households with access to tap water increased from 63.9% in 2000 to 86.7% in 2006. Rural households also expe-rienced an increase in incomes and living standards. The share of rural households with color televisions rose from 48.7% in 2000 to 89.4% in 2005.

Not only did current living conditions improve, but prospective conditions improved as well. That is, the share of young Chinese obtaining high levels of education rose substantially, thereby increasing expected future earning power. In 2006, 75% of high school students entered college and university. Thus the next generation of urban adults will be composed of many more skilled, middle-income workers. The expectation of future wealth will raise the confidence of young consumers and, perhaps, make them more willing to spend. The existence of this large army of educated young adults is one of the reasons why rapid future growth is expected.

In the years ahead, consumer spending is likely to rise significantly as a share of GDP as the economy restructures away from export dependency. Thus, overall growth of consumer spending is likely to be quite rapid.


Ownership of durables China’s urban consumers now possess many of the toys common to developed country households. This represents a dramatic change from just a few years ago. For example, in 2006 47.2% of urban households owned a personal computer, up from 5.91% in 1999.Today there are roughly 650 million mobile telephone subscribers in China, the most of any country in the world by far (in the US there are 260 million subscribers). This figure is up from 269 million in 2003. In addition, there are 117 million Chinese who access the internet from their mobile phones, up 133% over the prior year.

More common household electronics and appliances have been ubiquitous for somewhat longer. Since the mid 1990s, most urban households have possessed color televisions, washing machines, and refrigerators. Yet rural household ownership of such products has been growing rapidly. For example, 7.28% of rural households owned an air conditioner, up from 1.31% in 2000. Similarly, ownership of motor cycles, washing machines, TV sets and stereo systems has increased rapidly since the turn of the millennium. Thus a large number of Chinese consumers are techno-logically up-to-date and have access to vast amounts of technological and cultural information. These consumers, mostly young, are growing in number, are experiencing the preponderance of income growth in China, and are the most important target market for global companies interested in China. Notably, many are starting to enjoy the freedom of automobile ownership.

Automobiles China’s automotive market has seen a dramatic change in recent years, owing in part to the large reduction in import tariffs on automobiles following China’s entry into the WTO. Consequently, it is estimated that China has 35 million passenger vehicles on the road, up 164% from five years earlier. This number is expected to increase rapidly in the next several years. In fact, Chinese automotive sales in the first quarter of 2009 exceeded those of the US (although this was largely due to a near collapse in US automotive purchases). In the years ahead, China will be one of the world’s most important automotive markets along with the US, EU, and Japan.

Although the market for automobiles in China has grown rapidly, future growth will partly depend on the develop-ment of a sophisticated market for automotive loans. Further growth in automotive lending will depend, in turn, on a more sophisticated and freer lending market. This might entail freer interest rates (they are now government controlled) so that lenders can price loans according to risk. Moreover, recent improvements in the ability of lenders to monitor and assess consumer credit will enable the creation of a more profitable automotive lending market. In addition, the government has lately provided substan-tial financial incentives for rural households to purchase automobiles.

Once automobile ownership reaches a critical level, there will be a significant shift in shopping behavior. Ownership of cars enables larger transaction sizes and less frequent shopping trips, it enables longer distance trips (such as to out-of-town shopping centers) and enables a more diverse range of leisure activities.


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Spending on food Most Chinese prepare their meals when eating at home. Hence the market for packaged, frozen, or prepared foods is relatively limited — although it is growing. While the “yuppie” population of China is rising rapidly, young dual income professionals prefer to eat out rather than bring a prepared meal home. For those not yet married, they rely on a parent or grandparent to cook for them. Consequently, when it comes to meals eaten at home, the market for fresh foods is dominant and freshness is critical. Thus the rise of modern food retailers in China has been predicated, in part, on their ability to offer highly fresh foods with hygienic conditions superior to those of tradi-tional wet markets. Today, consumer spending on food, beverages, and tobacco accounts for about 28 per cent of total household spending.

Given that most Chinese have relatively small homes and limited storage space, and given the desire to eat only fresh foods, Chinese tend to shop frequently. Walmart says that a typical customer comes to their stores 3.5 times per week — much more than in the US. Thus the one-stop conve-nience of a big modern store is somewhat mitigated by the behavior of consumers.

Eating habits of Chinese consumers, both in urban and rural areas, have undergone significant changes in recent years. For example, between 2000 and 2005, per capita grain purchases declined in both urban and rural areas by 6.4 per cent and 16.5 per cent respectively. Instead, milk and meat products have become a major part of the consumption basket compared to 2000. The rise in per capita purchases of milk and related products has been rapid, rising from 2000 to 2005 by 80% and 170% in urban and rural areas respectively.

Another significant change has been the increasing avail-ability of imported food products, mostly in stores in urban areas. This accelerated after China’s entry into the WTO, which necessitated rationalization of import duties on imported food products.

Although lifestyles have changed significantly in urban China, the consumption of organic foods is yet to take off. After the United States, China has the largest area of land devoted to cultivation of organic produce; however,

China’s first organic supermarket in Shanghai had to shut down because of poor sales. As awareness of health issues rises with growing incomes, demand for health foods will likely catch up.


domestic consumption of organic food is far behind that of the US. This is mainly due to the high prices of organic food. China’s first organic supermarket in Shanghai had to shut down because of poor sales. As awareness of health issues rises with growing incomes, demand for health foods will likely catch up. This will open up a huge oppor-tunity for retailers and food suppliers.

On the other hand, there is a large and growing market for meals eaten out of the home. The success of fast food and quick service restaurants has been notable. For example, Yum Brands, owner of KFC, Pizza Hut, and Taco Bell, operates over 2,000 restaurants in 280 Chinese cities and continues to grow rapidly with strong profitability. Other Western chains have prospered in China as well. Although these chains offer Western style food, they have adapted to suit the tastes and habits of Chinese consumers. For example, although pizza is far removed from Chinese food, it has been popular because, like Chinese food, it can be eaten family style. Yet most restaurants in China are small, independent storefront businesses that were among the first to be privatized as China adopted a market oriented economy. Thus this market remains highly fragmented.

On the other hand, there is a huge opportunity for the consolidation of the restaurant industry. In urban China, millions of consumers love to eat away from home in countless, small restaurants. Many could become franchi-sees of large global or national chain operations. This has already begun to happen. Many more could be acquired by larger chains. Many small, privately owned restaurants and stores will be eager to join forces with foreign chains. There are several reasons: first, these companies often rely almost entirely on internal financing since, unlike state-owned companies, they lack access to domestic credit. A foreign link will enable outside financing. Second, private property rights are sometimes unclear. That is because, in order to obtain credit, companies will sometimes register as collectives and provide part ownership to government authorities. Yet such a government link can cause problems when selling a business or extracting profits. Thus, a rela-tionship with a foreign company is often preferable.

Spending on apparel and fashion The rise of a middle class, as well as a small affluent class, is creating opportunities to sell more than just basic, low priced clothing. Moreover changes in the rules governing foreign investment in China’s retailing sector are creating opportunities for medium sized retail chains to grow quickly in China.

Until a few years ago, foreign retailers had to have a minimum level of capital in order to invest in China. This effectively excluded all but very large retailers such as hypermarkets and home improvement centers. Many medium sized apparel chains were, thus, kept out of China. Instead, foreign fashion brands, mostly luxury purveyors, simply licensed their names to local Chinese companies which opened flagship stores to promote those brands.

Today, however, foreign retailers can open stores without substantial hindrance. Consequently, many apparel retailers based in Hong Kong and other Asian locations have opened stores in China. In addition, many global brands are undertaking a multi-channel approach to the Chinese market. This includes franchising, operating their own stores, and selling their brands to department stores. Until recently, there were basically two types of apparel sold in China. First, there was low priced, basic apparel sold under

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local brand names offered in Chinese department stores, foreign hypermarkets, or small family-owned specialty chains. Second, there were luxury brands sold either in franchised boutiques or upscale department stores. There was not much in between.

Today, a middle level of apparel is developing. This involves quality brands, both Chinese and foreign, being sold in department stores and specialty chain stores — the latter mostly foreign operated or franchised. American Apparel is the latest entrant into this market and plans to sell mid-range apparels manufactured in the US. This market includes such companies as Giordano, Esprit, H&M and Zara. In the case of the latter, the company sees its brand as being upscale but not luxury. It is affordable to the middle class but at a relatively high price point. It is this segment where considerable growth is possible in the coming years.

The consumers who are purchasing this new middle level of apparel tend to be China’s burgeoning professional class. They are relatively young, well educated, have discretionary purchasing power and aspire to a better life. Moreover, increasing participation of women in the workforce translates into higher levels of discretionary spending by Chinese women. This segment is an important target for high-end retailers. Their sense of fashion is highly influenced by European luxury brands and by Japanese styles and pop culture to a lesser extent. Hence, chain apparel retailers tend to offer styles commensurate with such tastes.

Aside from a prospective invasion of foreign specialty apparel chains, the other big potential change in Chinese apparel retailing is the privatization of state-owned department stores. Today, these stores still account for a sizable share of the clothing sold in China — and they are generally poor merchants. That is because they tend to follow the Japanese model of department store manage-ment. This involves offering branded suppliers selling space on a concession basis. The inventory risk is borne by the supplier and the department store is essentially a property manager rather than a merchant. The result is a poor mixture of styles and brands.

When privatization has taken place, it has sometimes involved improvements in merchandising. For example, Malaysian department store retailer Parkson has sold management contracts to some privatized department stores. The result is a more modern and focused shopping experience in which brands are better showcased and the brand mix is more rational. In the future, further such endeavors should result in better opportunities for the selling of global brands.

Savings Chinese households are famous for saving a large share of their income. As mentioned earlier, per capita urban household income rose more rapidly than consumer spending in recent years. The result was a large increase in the size of per capita household savings accounts. The value of total household savings accounts in China rose 151.1% from 6.4 trillion yuan in 2000 to 16.1 trillion yuan in 2006. Most of that money is now held as deposits in four state-owned banks as well as the Postal Savings system which is expected to be privatized. In addition, global retailers and consumer product suppliers are also eager for those consumers to part with some of their savings.

Honoring its commitments to the WTO, China has allowed foreign banks to offer comprehensive retail financial services to Chinese consumers since the end of 2006. Not surprisingly, leading global financial institutions such as HSBC, Deutsche Bank, and Standard Chartered have set up operations in China. However, assets of foreign-invested banks make up just about 2.4 per cent of total assets of financial institutions nationwide. Their gross assets at

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the end of 2007 included US$95.1 billion in outstanding loans. It is possible that, when the global financial system recovers, foreign banks will acquire smaller Chinese banks in order to increase their reach in China. It is also possible that Chinese consumers will be offered a more diverse range of savings instruments including some that offer historically higher returns. This, too, could lead consumers to save less.

Why do Chinese save so much? Consider why people save at all: economists believe that consumers save in order to smooth their lifetime consumption. If they expect that their earning power will diminish substantially in old age, they will save in order to maintain their living standards during retirement. In addition, consumers save in order to allay the risk of extraordinary expenditures such as healthcare. In urban China, pensions and healthcare have tradition-ally been the responsibility of state-owned enterprises. As many of these companies have been privatized, this social safety net has been diminished. The result has been increased saving as consumers feel more vulnerable. It should also be pointed out that, at the time the market economy started to be introduced in the 1980s, Chinese consumers had virtually no savings. Thus their behavior is, in part, an effort to catch up.

Today Chinese consumer savings is quite high for a rela-tively poor country. Therefore the question arises as to whether the rate of saving will decline in coming years now that consumers have achieved a reasonable amount of wealth. There are indications that consumption is beginning to edge investment and exports as the leading contributor to GDP growth. Moreover, it is reasonable to expect that this trend will continue for a variety of reasons.

One important factor concerns the mix of urban and rural population. Rural Chinese tend to save a higher share of their incomes than urban Chinese because rural residents have almost no social safety net on which to rely. As rural residents continue to migrate to the cities, the savings rate should decline.

Chinese must save in order to purchase big ticket items as well as to accumulate initial payments for purchases of homes. Yet as consumer credit becomes widely available, consumers will be able to smooth purchases of big ticket

items thereby reducing the necessity of saving. In addition, in the early part of this decade the government allowed banks to require smaller initial payments for obtaining a home mortgage. The government also made mortgage interest payments tax deductible. These actions should have the effect of encouraging more home ownership and reducing the amount of saving needed in order to purchase a home.

Finally, just the fact that millions of Chinese own their homes should depress saving. That is because homes are a form of wealth. If consumers expect that the value of their homes will increase in the future, that diminishes the need to save in order to achieve a particular level of wealth.

On the other hand, there is one important reason to expect that personal savings in China will remain relatively high for a long time. That is because there appears to be a strong cultural bias toward savings. Indeed those Chinese who possess credit cards generally do not maintain a balance and pay off their debts as quickly as they can.

Housing and consumer credit China’s consumer economy is in the process of becoming a credit driven market. Until relatively recently, almost all consumer transactions involved cash and most consumers held no debt of any kind. That has already changed dramatically since 2001 when home mortgages and auto-motive loans were introduced. Since then the market for consumer credit has evolved rapidly. Mortgages were an important component in the rapid privatization of govern-ment owned housing. Increased availability of home loans has spurred purchases of homes, leading to a threefold increase in home prices since 1998.

Rural Chinese tend to save a higher share of their incomes than urban Chinese because rural residents have almost no social safety net on which to rely.

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Housing privatization should, over time, have two major effects on the consumer market. First, when people own their homes they possess tangible wealth. Economists have long known that the tradeoff between spending and saving is influenced by consumer perception of wealth. The greater the wealth, the less need to save. Moreover, housing prices rose substantially until last year. Thus, there are now millions of Chinese with considerable wealth and the expectation of rising wealth. This should stimulate more consumer spending in the future. It should also stimulate Chinese consumers to tap into their consider-able financial savings for large purchases. Finally, it should make Chinese consumers more comfortable in taking on non-mortgage debt such as automotive loans and credit card debt. Second, when people own their homes they tend to spend more on their homes. This means deco-rating, fixtures, and other forms of home improvement. It also means furniture and furnishings, electronics, and appliances. Thus housing privatization should stimulate spending on home related goods. Indeed, this has happened and is the primary reason for the accelerated investment in China by foreign home related retailers such as Ikea, B&Q, Kingfisher, and soon Home Depot.

Consumption using debit cards accounted for 21 percent of total retail sales in 2007, up four percent from the previous year. There were a total of 1.47 billion cards issued by Chinese banks by the end of 2007, of which only 70 million were credit cards — a rise of 140 percent from the previous year. In general, it is very difficult for an average citizen to get a credit card from the banks. The Chinese government has only recently allowed foreign banks to issue credit cards. It is expected that, as competi-tion between banks for issuing credit cards grows, many banks will waive annual charges to make credit cards more attractive to the consumers.

On the other hand, using credit for consumption is consid-ered inappropriate in Chinese culture. This attitude among consumers can become an impediment for the growth of consumer credit. For example, at the end of 2007 outstanding payments on credit cards stood at only 75 billion yuan (US$ 10.4 billion), which was well below the 630 billion yuan in credit lines available in China.

A significant development in the last two years has been the establishment of a credit database that links all local commercial banks and rural credit cooperatives. By mid-2007 the database had information on 570 million people and 12 million businesses. With access to this infor-mation, banks can profile their consumers and make better decisions before extending credit to consumers. Such a system will lay the foundation of a salubrious banking system, promote the development of a robust consumer loan market, and encourage consumers to develop disci-plined credit habits. This is important because, prior to this development, default rates on consumer loans were unusually high. This was due, in part, to a lack of informa-tion about credit history. Shopping for the home As mentioned, home ownership in China has skyrocketed. The result is a strong demand for home related products and home improvement. Keep in mind that, when Chinese purchase a new flat in a high rise building, they are essen-tially purchasing rooms that are no more than empty concrete boxes. Everything else must be added by the owner including plumbing, electrical wiring, shades and curtains, bathroom and kitchen fixtures and appliances, and flooring. Thus, the market potential is considerable. Although several foreign and domestic home improve-ment retailers have opened stores in China (Kingfisher, Obi, Home Way, Home Depot), about 80% of home improve-ment spending still involves less efficient channels. For example, in most big cities in China, there are neighbor-hoods where the businesses specialize in home improve-ment. Entire blocks are devoted to small, independent shops that each offer particular products and brands (pipes, kitchen fixtures, baths, etc). Consumers must go to a wide range of stores in order to put together the compo-nents for a project. They then hire laborers to perform the work as “do it yourself” is not part of Chinese culture — especially given the low cost of labor.


So what is the competitive advantage of a big home improvement center? These modern stores are targeted at educated professionals who are pressed for time and enjoy the convenience and quality of modern shopping processes. These consumers are also brand conscious and appreciate the selection of premium brands found at modern stores. Moreover, they may also appreciate the authenticity of such brands at modern stores given the high level of counterfeiting that takes place in China. Finally, these consumers appreciate the reliable information that can be obtained from the service staff at such stores. Given the low cost of labor, modern home improvement stores can offer a large number of well trained staff to assist shoppers in planning projects. For example, each B&Q store in China has a design center where designers help customers make the right decoration choices for their homes. Some stores have also started selling electronics and home appliances to offer a comprehensive range of products for the home.

Given these competitive advantages, the market share of modern retailers is expected to rise rapidly in the next few years as retailers invest in expanding. Moreover, in coming years as the secondary market for houses develops, consumers will look towards one-stop home improvement stores to make wholesale changes to existing houses.

Attitudes toward brands Chinese consumers appear to have mixed attitudes toward brands. When it comes to luxury products or products for which quality is perceived as highly important, consumers are highly brand-conscious. Thus luxury brands are sought after when purchasing apparel, footwear, jewelry, or cosmetics. When purchasing home-related products, brands are important as well. Chinese consumers prefer to spend more on a known brand name for such products as kitchen and bathroom fixtures, appliances, house wares, and furniture. All of these are products that may be seen by others. Thus the status of the brand is critical.

On the other hand, for many packaged goods that have commodity-like appeal, and which friends and neighbors are not likely to see, brands hardly matter. The ability of some packaged goods suppliers to create strong brand identity and loyalty is, therefore, quite notable.

The fact that premium brands in fashion and home goods are so popular in China is one of the reasons that counterfeit goods have become such an important issue. Counterfeit items enable consumers to obtain the best brands without having to pay premium prices. Moreover counterfeiting, both for the domestic and export markets, has become a huge industry in China. Although senior government officials have expressed concern about the issue, combating piracy is difficult due to the massive infrastructure already in place. In addition, the industry is often protected by local law enforcement. For producers of branded products, this is one of the biggest obstacles to doing business profitably. In the last few years, courts in eastern China have passed some key judgments to protect foreign manufacturers’ intellectual property. In addition, the Chinese government has developed a national policy on intellectual property rights.

Finally, there is the issue of Chinese versus foreign brands. This is a complex issue because attitudes have changed over time and are different depending on the type of product. In the early days of economic reform in China, foreign brands were generally preferred as Chinese consumers recognized the inferior quality of state-produced products. Yet as the economy developed, state-owned companies were privatized and many became much better producers. Pride in the nation’s accomplishments compelled some consumers to prefer local brands, all other things being equal.

Today, a more sophisticated consumer appears to be relatively ambivalent about this issue. While nationalism is a strong political attitude, when it comes to business consumers have become comfortable with the nation’s achievements. As such they don’t feel the need to support local brands in order to promote their country’s interests. So while Chinese retailer Lianhua emphasizes its Chinese roots, many analysts attribute the company’s success to

Pride in the nation’s accomplishments compelled some consumers to prefer local brands, all other things being equal.

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good management rather than national pride. The impli-cation is that foreign brands should not necessarily be at a disadvantage in China. Indeed some observers believe that Chinese consumers regard foreign brands as generally having higher quality. If so, consumers will be willing to pay a price premium for a foreign brand.

There are products and services for which foreign brands will have a natural advantage, while there are those for which no such advantage exists. It makes sense for foreign companies to avoid those products where they lack any advantage over Chinese companies. For example, foreign makers of rice noodles might have difficulty developing brand equity with local consumers given the availability of well regarded and venerable local brands.

Regionally, there is wide variation about brand percep-tion across China. For example, in the northern region of China appearance and status are key drivers of spending on luxury goods. In the eastern region, where disposable incomes are high and the workforce well educated, there is a strong demand for the latest offerings of leading inter-national brands. This is less so, however, in the central and western regions.

Attitudes toward price and quality Chinese consumers are price sensitive, of course. Yet as the discussion about brands indicated consumers are quite concerned about other attributes of a product or service and will often pay a premium price.

Yet brand name is not the only attribute that concerns Chinese consumers. They also value customer service (despite or because of it’s paucity in China), entertain-ment, and community involvement. For example, Yum Brands, operator of KFC and Pizza Hut restaurants in China, employs four to six people per restaurant for the purpose of developing community relations. These people interact with children and the elderly and organize community events. The goal is to convey the impression that these restaurants are an integral part of the community. Of course given the low wages in China, doing such outreach is more affordable than would be the case in the US or Europe.

Income distribution As a nominally Communist country, China is expected to have a relatively even distribution of income. Yet China has a de facto capitalist economy which, although it produces rapid growth, possesses many of the vices and inequi-ties typical of a market economy. This includes growing inequality of income and living standards. Specifically, there is a sizable gap between the lifestyles of rich and poor, urban and rural, coastal and interior.

Government leaders have expressed growing concern about this gap and have proposed policy measures aimed at reducing the gap and alleviating its social effects. In November 2007, the Ministry of Commerce revised the Catalogue for the Guidance of Foreign Investment Industries in which it dropped the article limiting foreign investment in central and western regions of China. This will help these relatively backward regions catch up with the prosperous coastal region of China. On the other hand, the high standard of living of China’s top earners offers a significant and growing opportunity for global consumer business companies.

Consider a few facts. First, the per capita income of the top 10% of urban households in 2006 was 9 times that of the bottom 10% and 3.15 times that of the middle quintile. The per capita living expenditures of the top 10% of urban households, however, was 6.15 times the bottom 10% and 2.66 times the middle quintile. These lower ratios reflect the fact that higher income households tend to save a much larger share of their incomes.

The gap in income levels is also reflected in ownership of major durable products. For example, in 2006, for the top 10% of urban households there were 20.11 automobiles per 100 households. Among the bottom 10%, there were almost no automobiles. Even among the middle quintile, there were 1.9 automobiles per 100 households. Similar differences exist for many other durable products. For example, 91.3% of the top 10% of urban households owned a personal computer in 2006 while 47.2% of all urban households owned a computer.


Regional differences The inequality in income and living standards in urban China roughly corresponds to geographic differences. The major coastal cities such as Shanghai, Beijing, Guangzhou, and especially Shenzhen were the first to experience market oriented reforms. As such, they grew faster over the past 20 years than most other parts of China and have emerged relatively affluent.

For example, average disposable household income in Beijing is roughly US$3,000 at current exchange rates, not far below the average for the top 10% of urban house-holds nationwide (US$5,000). The national average for all urban households is roughly US$1,678. Consequently, it is reasonable to infer that the top 10% of households in Shanghai, Beijing, and Guangdong have very high incomes by Chinese standards. If Shanghai’s income is distributed similarly to the national pattern, then the top 10% of Shanghai households has an average income of US$15,000 at current exchange rates. Using an exchange rate that measures the true purchasing power of the currency, this would translate into an average purchasing power of approximately US$60,000 per household.

There are also big geographic differences in the way that Chinese spend their money. In Shanghai, people spend far more than the national average on food, housing, recre-ation, transportation, and communication. Yet interestingly, Shanghai residents are much less likely to own an automo-bile than residents of Beijing or Guangdong Province. Some geographic differences in spending may be due to differ-ences in regional prices. For example, housing in Shanghai is far more expensive than in many other provinces. Indeed, given such differences in the cost of living, the relative affluence of Shanghai may be overstated.

Not only are there differences in income between the coastal and interior regions, there are also differences within urban centers. In the big coastal cities that have experienced breakneck growth in the past two decades, poorer citizens have been pushed to the periphery as home prices near the center have skyrocketed. The result

is not unlike other cities the world over. The affluent live close to the center of things and lower income households populate the edges of the cities. Indeed housing designed for lower to middle income consumers is growing on the outskirts of big cities. Big discount retailers are following consumers to these locales.

Finally, regional differences are not simply about money. China is a highly diverse nation, with many languages, life-styles, types of food, and business styles. Companies doing business in China must take account of these differences when choosing product and service mixes as well as when managing local enterprises.

In addition, China is not a single entity when it comes to doing business — especially consumer business. After all, during the period prior to market-oriented reforms (the communist era), each city in China was relatively self-sufficient economically. Local factories produced consumer goods under local brand names and distributed locally. Thus consumers became accustomed to local brands and distribution was highly fragmented. Although this is starting to change, especially with the construction of a national transportation infrastructure, consumer business remains highly localized. To the extent that there are national consumer brands, they are mostly global brands or private labels of global retailers. China remains at the early stages of developing a national consumer goods distribu-tion system.

What does this mean for global retailers and branded suppliers of consumer goods? It means that business must be organized around local distribution. Hence a retailer operating in several cities must deal with different local distributors for the same product. Retailing remains highly fragmented and primarily local, so branded suppliers must deal with thousands of different major retailers in each local market. This localization retards the ability to develop large-scale efficiency. Still, as the transportation infrastruc-ture develops, and as national retail organizations develop, the distribution system is gradually shifting toward a national model.

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Demographics China’s population growth is relatively slow. Over the next 20 years the population is only expected to increase by 11% to about 1.45 billion. Yet, given China’s large popu-lation, this represents an increase of 147 million people, or more than the population of Japan. More interesting, however, is the way in which the age distribution is expected to change. Because of declining fertility rates and delayed marriage and childbirth, the number of children and young adults will decline considerably. The under 20 population will drop by 49 million over the next 20 years. In addition, the number of young adults (ages 20 to 34) will decline by 42 million. On the other hand, the number of middle aged adults (ages 50 to 64) will increase by 134 million or 73%. The number of elderly (over 65) will double from 99 million to 199 million.

The trends noted above are already well under way. In just the past five years, it is estimated that there has been a dramatic shift in the age composition of the population owing to rapidly changing rates of fertility. For example, the under 20 population declined by 22 million from 2000 to 2005 while the 20 to 34 year old population fell by 25 million. Meanwhile the older cohorts have experienced large increases.

Finally, among children and young adults there is a large disparity between the numbers of males and females. For example, in 2007 there were 46.7 million males aged 5 to 9 while there were only 40.7 million females in that age group. Similar differences exist for many other young cohorts. This unusually large gap is due to the one-child policy followed over the past generation. The desire for sons led many Chinese families to undertake measures aimed at assuring male births. This gender disparity could have significant implications for lifestyles of adults in the future. Moreover, it could have an adverse impact on social stability and crime as a large number of men fail to find permanent mates. Finally, it is widely believed that a relative dearth of young females will exacerbate the low rate of fertility.

What do these demographic trends augur for consumer business in China? First, the absolute decline in the number of dependent children means that there will be far fewer households in which children are present. This implies less spending on child and teen related products (clothing, toys, and games). It also implies that there will be more money available for adults without children to spend on themselves. Those adults who don’t have children or delay having children will likely spend more on eating out, deco-rating homes, travel, and entertainment.

Second, the increase in the older working age population (50 to 64) has important implications. This age group tends to save more and spend less. It tends to spend more on services and less on goods. It also tends to spend consider-ably on grandchildren.

The huge increase in the number of elderly Chinese will have vast implications for many industries including healthcare, pharmaceuticals, recreation, fashion, home furnishing, and food service to name a few.


China and the internet

As in many developed countries, the growth of internet usage in China has been phenomenal. What makes China’s experience exceptional, however, is the fact that China has so many people. Consequently, the numbers involved are sufficiently large to attract the attention of many of the world’s leading internet sellers. Such venerable US internet companies as Microsoft and Google are highly active in China. These and many other companies have ambitious plans for future growth in China.

By the end of 2007, there were 210 million internet users in China, which can now boast of having the second highest number of internet users in the world after the United States. Internet usage increased by 53 per cent in 2007. However, with only 16 per cent of its population online, the Chinese are still below the world average of 19 per cent. An important caveat is the fact that only a fraction of Chinese internet users own a PC. A majority of them throng internet cafes in order to access the Internet.

The number of broadband internet users in China reached 163 million in 2007, which is 86 per cent of all the internet users in China. According to the China Internet Network Information Center (CINIC), 55 million of China’s internet users shopped online last year with the total value of their transactions amounting to almost 60 billion Yuan (approxi-mately US$8.2 billion). It is estimated that this grew to US$13.4 billion by 2008. At present, online sales account for less than one percent of total retail sales, but CINIC predicts that this figure will rise to between five and eight percent by 2012.

The recent boom in the number of internet users has created a market of significant size for consumer oriented companies. They can reach out to their consumers directly either by selling their good and services online or by adver-tising online to create product awareness. Online adver-tising would also serve as an incentive to create world-class Chinese portals.

According to CINIC, 40 percent of the new users in 2007 resided in rural areas. With a sizeable chunk of new internet users concentrated in the rural areas, there is a completely new market opportunity awaiting companies. Increased internet usage in rural areas will enable consumer oriented businesses to reach out to these

consumers without necessarily having a strong physical presence in those areas.

Although it is clear that the internet will rise in importance in the years to come, there are several issues that will determine the success of internet commerce. These include the reliability of the postal service, the ubiquity of credit and debit cards, and the degree to which store retailers will play a role in the distribution of goods ordered online. Retailers will need to build and promote secure portals to encourage internet users to shop online. This would require them to add a completely new IT department to their operations. So far, very few have done so. PPG is an exception, which has been very successful by selling men’s shirts to consumers online.

Ultimately, the rise of consumer credit in China will increase online spending over time as will the advent of 3G mobile phone capabilities by improving internet speed and accessibility for China’s vast army of mobile phone users. Meanwhile, the rise of online pay systems has enabled consumers without credit cards to shop online. For example, Alibaba’s AliPay system has been a notable success in China. It requires the purchaser to put money into an account. The seller affirms that there is sufficient money for the purchase and sends the goods to the consumer. The account is now held in escrow by AliPay. The consumer receives the goods and, if satisfied that this is what was ordered and the quality is good, releases the funds to the seller.

Finally, Chinese consumers are concerned about the quality of the products they purchase online as they are not able to assess them in person. This suggests that strong brands will fare much better in an e-store. Going forward, manufacturers and retailers will have to be very cautious and transparent with respect to the quality and pricing of their products. At the same time, by revealing consumer preferences and behavior, internet usage data can help companies to better plan and time their marketing activities.

China’s consumer market Focus area of publication 21

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Short term economic outlook

When the global economic crisis of 2008-09 began, it was widely expected that the big emerging markets would be somewhat immune to the full impact of the downturn. The conventional wisdom was that these countries had, to some extent, decoupled from the West. That is to say, they had become less dependent for their growth on exports to the US and Europe. They were more dependent on other emerging markets as well as their own domestic demand. There was, indeed, truth to this view. Yet, although emerging markets such as China had indeed become less dependent on the West, they remained dependent none-theless. Hence, when the crisis came, it wreaked havoc with emerging markets.

In the case of China, its economy was already set to slow down due to the lagged effects of a tightening of credit by the central government. This was undertaken in order to pop a property price bubble as well as suppress infla-tionary pressures that had begun to be onerous. In other words, China’s economy had started to overheat. Then, when the global crisis took hold, China was hit by a sharp drop in demand for its exports. The result was a marked slowdown in growth, led by a sharp drop in exports. From a human perspective, this has meant the shutting down of thousands of factories and the dismissal of millions

of workers. The government reported that roughly 20 million migrant workers lost their jobs at factories in the big coastal cities. Many have returned to their rural and inland villages. Thus, a reversal of a long-term rural-urban migration has taken place.

Yet, despite this sharp reversal of fortune, China’s consumer market has remained surprisingly robust with retail sales rising at a strong pace. Why is this? There are several reasons. First, job losses have largely been confined to low wage workers in coastal factories. Yet a dispro-portionate share of retail spending is undertaken by the middle class and affluent consumers who work in China’s services sector. These consumers have not, by and large, experienced large job losses.

Second, the fiscal stimulus undertaken by the govern-ment to counter the loss of export demand is having a positive impact on domestic demand. Moreover, it is being funneled substantially into healthcare and education. The need for consumers to spend on these categories has generally led them to save heavily as a precaution. It is hoped that more government spending on these catego-ries will discourage such saving.

Third, the existence of a massive pool of consumer savings means that, even in a period of economic uncertainty, consumers feel comfortable maintaining their level of spending as they can, if necessary, dip into their savings.

Finally, consumer prices in China are now stable while house prices have fallen. Moreover, an easing of credit conditions by the monetary authorities is boosting demand. All of these factors are playing a role in stimu-lating consumer spending.

It is expected that China will recover quickly from its doldrums and that economic growth will resume at a rapid pace. As China’s economy recovers, consumer demand is likely to be very strong.


Strategic requirements for success

What are the requirements for success in the Chinese consumer market? Based upon examining the experi-ences, both positive and negative, of numerous consumer oriented companies in China, this brief and incomplete list of success criteria is offered:

Employ good local managers This is a necessary condition for success. Even if all other aspects of a business are correct, the absence of good managers will condemn the investment to failure. Yet this is highly challenging. The demand for good managers in China is growing faster than the supply. The result is that the cost of managers is rising. Yet more onerous is the fact that the ability to retain good managers is declining. After obtaining training, a good manager will often be vulner-able to the pecuniary offerings of rival companies. The question arises, then, as to how to induce loyalty without paying ransom. There is no easy solution. Still, an effort must be made to instill a sense of long-term involvement and opportunity with a company. Some foreign companies operating in China take their managers on trips to the home country to obtain both training and a sense of “esprit de corps.” Managers must feel that the company has good prospects and that there are long-term career opportunities.

Invest for the long-term Success in China does not usually happen overnight. It requires painstaking attention to detail and the develop-ment of a local organization that is integrated into the local culture and business environment. It often entails much trial and error. Any decision to operate in China’s consumer market must entail the expectation that returns will be substantial, but will take time to reap. It is notable that many Japanese companies send executives to China with the expectation that they will stay there until retirement. Western companies, on the other hand, often send execu-tives for temporary tours of duty. While a lifetime commit-ment is not necessarily the answer, a sense of long term expectations is entirely appropriate.

Stay true to core competencies (which are not easily defined) It is a mantra of business schools that companies must focus on their core competencies. Yet when investing in China (or any other emerging market), this is not a trivial issue. After all, it is not always a simple matter to identify the core competency. Take the KFC division of Yum Brands, for example. In China, KFC restaurants offer a considerably different menu than in the US. Clearly it is not fried chicken that is the core competency. Instead, it is the ability to manage a large restaurant chain. Defining the core compe-tency is critical when fashioning a business strategy for the Chinese consumer market. Companies must ask themselves the following questions: What do we offer consumers that will attract them? How are we different from potential competitors? What can we do well in China and what can Chinese companies do better?

Recognize and adapt to unique cultural differences While staying true to core competencies, companies investing in China must also adapt to the needs of the local market. Naturally this includes adjusting the mix and attri-butes of the products and services sold. Yet it also entails adjusting to the business culture of China — or rather the many business cultures of China. After all, China is a fairly diverse country, with many dialects and many different cultural attributes. For example, some companies operating in China have indicated that customers and managers are quite different in Beijing than in Shanghai. These differ-ences can involve work habits, attitudes toward customers, shopping behavior, and receptiveness to marketing messages. Companies must take account of these differ-ences when developing a strategy.

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Concluding thoughts

China’s consumer market has the potential to account for a disproportionate and significant share of growth for the world’s leading consumer oriented companies in the coming years. The challenge will be to navigate the risks and obstacles of operating in the Chinese market while taking full advantage of the opportunity that rapid growth is creating. This will entail exploiting a company’s best features while adapting to local needs. It will entail extending a company’s culture to a new environment by integrating local managers into that culture. Finally, it will entail creating a truly Chinese organization with mostly Chinese managers who are loyal to the company and intend to make a career to building the business.

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AuthorDr. Ira KalishDirector, Global EconomicsDeloitte ResearchDeloitte Services LPUSATel: +1 213 688 4765e-mail: [email protected]

ContributorVinay Hukumchand Senior AnalystDeloitte ResearchDeloitte Support Services India Private LimitedUSATel: +1.615.718.5150e-mail: [email protected]

U.S. Industry LeadersConsumer ProductsPat ConroyDeloitte LLPTel: +1.317.656.2400e-mail: [email protected]

RetailStacy JaniakDeloitte LLPTel: +1.612.397.4235e-mail: [email protected]

Chinese ServicesClarence KwanDeloitte LLPTel: +1.212.436.5470e-mail: [email protected]

Global Industry LeadersConsumer BusinessLawrence HutterDeloitte MCS LLPUKTel: +44 20 7303 8648e-mail: [email protected]

Chinese Services GroupLawrence ChiaDeloitte Touche TohmatsuHong KongTel: +1 852 2852 1094e-mail: [email protected]

John JeffreyDeloitte LLPUSATel: +1.212.436.3061e-mail: [email protected]

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